Monday, April 17, 2017

Why Markets Are Inefficient: A Gambling ‘Theory’ of Financial Markets for Practitioners and Theorists

From the Social Science Research Network:

Last revised: 12 Apr 2017Date Written: February 22, 2017

Abstract

The purpose of this article is to propose a new “theory,” the
Strategic Analysis of Financial Markets (SAFM) theory, that explains the
operation of financial markets using the analytical perspective of an
enlightened gambler. The gambler understands that all opportunities for
superior performance arise from suboptimal decisions by humans, but
understands also that knowledge of human decision making alone is not
enough to understand market behavior — one must still model how those
decisions lead to market prices. Thus are there three parts to the
model: gambling theory, human decision making and strategic problem
solving. A new theory is necessary because at this writing in 2017,
there is no theory of financial markets acceptable to both practitioners
and theorists. Theorists’ efficient market theory, for example, cannot
explain bubbles and crashes nor the exceptional returns of famous
investors and speculators such as Warren Buffett and George Soros. At
the same time, a new theory must be sufficiently quantitative, explain
market ”anomalies” and provide predictions in order to satisfy
theorists. It is hoped that the SAFM framework will meet these
requirements....